If Morningstar’s research has one consistent message, it’s this: your biggest advantage or your biggest obstacle is rarely the fund you choose – it’s usually your own behaviour.

Across decades of research, Morningstar has examined how investors overreact to market falls, are seduced by strong short-term performance, miss time purchases and sales, and even why Australians tend to behave better than investors in many other countries.

Below are some of Morningstar’s most useful pieces of research on investor behaviour and what individual investors can learn from them.

Mind the Gap: Your behaviour can cost more than high fees

Our flagship research paper on investor behaviour is Mind the Gap. There’s plenty of research and media coverage on how funds perform. The purpose of Mind the Gap is to quantify the impact of investor behaviour on returns.

The study compares the return generated by the fund to the return actually earned by the average fund investor after accounting for the timing of purchases and sales. Those two numbers can significantly diverge.

The latest study found the average investor earned 1.2% less each year than the investments they owned because of poor timing decisions. This isn’t because investors choose terrible funds. It is because they often buy after strong performance and panic during market falls by selling near the bottom. Many investors miss the recovery and only return to investments after the market feels ‘safer’.

Over decades, that behavioural gap compounds into meaningful differences in wealth. Take for example an investor who starts with $100,000 and invests $1,000 a month for 20 years. Poor behaviour could reduce the end portfolio balance by almost $150,000. That’s over 20% of the account balance.

Investor behaviour model

The lesson is your investment strategy only works if you can stick with it. Part of this is having a clear, concise strategy that you can follow over the long term. This leads into the next insight from an extended edition of Mind the Gap.

Australians are among the world’s best investors - and there’s a structural reason for the good behaviour

The global Mind the Gap study looks at the disparity in results across countries. Australian investors consistently ranked among the world’s best at capturing investment returns. That doesn’t necessarily mean Australians are better stock pickers, but points to the way our market is structured.

Our compulsory superannuation system contributes to higher returns for Australian investors, by encouraging better investing behaviour.

Super has several characteristics that investors can replicate outside their retirement savings to achieve better results.

  1. Regular contributions. These contributions are invested regardless of market conditions. There’s no market timing.
  2. Limited trading. Due to disengagement with superannuation, limited transactions in and out of funds occur.
  3. Long investment horizons. Forced savings over long periods without the ability to cash in the investment early.
  4. Less attention to daily market movements. The lack of access means less attention paid to daily market movements.

In other words, the structure of super encourages discipline. Success isn’t about finding better investments but instead about having a better process.

The less you trade, the better you do

One of the recurring themes across Morningstar’s behavioural research is that activity is often mistaken for progress. When markets become volatile, investors feel an urge to ‘do something.’ There’s a temptation to constantly reposition portfolios. Action feels productive. This action bias often harms returns as reacting to headlines creates more damage than the market environment itself.

This is a mindset shift for many investors. A diversified portfolio is not designed to maximise returns in every market environment. It is designed to create a portfolio that survives many different environments while achieving a set of goals. That means some parts of the portfolio will almost always feel disappointing at any given moment.

The result of ‘doing something’ can often mean crystallising losses, increasing tax, paying transaction costs or missing recoveries.

Morningstar’s behavioural work consistently shows that the biggest driver of poor investor outcomes isn’t market volatility itself but how investors respond to volatility. For long-term investors, sometimes the hardest decision is doing nothing. It may not feel natural but it can be the most profitable decision.

Market volatility is when behaviour matters most

Our research shows that the investor return gap widens during periods of market stress. Loss aversion means losses feel worse than gains. When markets fall sharply, emotions become stronger.

Investors often react to volatility by abandoning long-term plans and selling quality investments or avoiding the market all together.

The implication of the pattern of poor behaviour during volatile times is an investment plan shouldn’t just be judged on how it performs during calm markets. The true measure of a plan is how it performs when seas are rough.

Build systems that remove emotion

One of the strongest themes running through Morningstar’s behavioural work is that successful investors rely less on willpower and more on systems. This is why the structure of superannuation has worked well for Australian investors. Having an Investment Policy Statement (IPS) can do the same across portfolios in or out of superannuation.

An Investment Policy Statement (IPS) stipulates the frequency of contributions, regular portfolio review timeframes, asset allocation and rebalancing rules.

These systems reduce the number of emotional decisions investors need to make and provides guidance during volatile markets.

You can find the step-by-step instructions to building your own IPS here. My colleague Mark has run through how to define an investment strategy and how it governs his decisions here.

Final thoughts

Many investors assume better outcomes come from finding better investments. Morningstar’s research suggests a different conclusion. For most people, the greatest opportunity isn’t improving their portfolio – it’s better understanding the person managing it.

Get Morningstar’s insights in your inbox